Turnbull's tax cuts a political stunt that ignore a hard truth

Treasurer Scott Morrison and Prime Minister Malcolm Turnbull addresses the media during a press conference at Parliament House in Canberra on Thursday 30 November 2017. fedpol Photo: Alex Ellinghausen

For the past few weeks, I've been mounting the argument that it's time for interest rates to start rising in 2018.

That's partly because it's no longer clear the economy is weak enough to justify the emergency, record low setting of monetary policy. It's also as a pre-emptive measure, to stem the distortions that come from having very low interest rates for a prolonged period.

So where does that leave the other major arm of economic policy making: that of fiscal policy, or the manipulation of taxes and public spending by the government?

The year has begun with much talk - from the government, at least - of the need to cut taxes, both the corporate tax rate and personal income taxes.

Indeed, it is already speculated that the budget handed down in May will contain cuts to personal income taxes.

The political motivation is clear, as another election approaches.

The policy rationale is less clear, particularly given the trajectory of government debt is still climbing.

It's worth spending some time reflecting how such tax cuts would sit within the government's "medium term fiscal strategy", which is "to achieve budget surpluses, on average, over the course of the economic cycle".

It's a strategy to which government of all stripes have been committed to - with some variations on the theme - since the 1990s.

In practice, it means that governments are committed to letting the budget's "automatic stabilisers" work to smooth out the economic cycle. When the economy turns sour - and joblessness rises - the budget is automatically plunged in the direction of deficits, as tax revenues from wages and profits fall and expenditure on payments, like the jobless allowance, rises.

The aim of the game is not to balance the budget every year, but to ensure that, over the medium term, surpluses outweigh deficits, meaning the government does not have to go deeper into debt to finance itself.

Since the global financial crisis, successive governments have also had a bipartisan commitment to a "budget repair strategy", namely, to "deliver sustainable budget surpluses building to at least 1 per cent of GDP as soon as possible, consistent with the medium-term fiscal strategy".

That budget repair strategy comprises three further commitments, that 1) all new spending will be offset by reductions in spending elsewhere, 2) improvements in the budget bottom line will be "banked" as improvements, rather than spent, and that 3) the government will outline a clear path back to surplus.

So, how is the government doing?

According to the government's midyear economic fiscal and economic outlook released just before Christmas, the federal budget is expected to be in deficit by $23.6 billion this financial year. That's an improvement on the May budget's forecast of $29.4 billion.

Another large deficit, of $20.5 billion, is also expected for the financial year coming, before the budget moves to a slim deficit of $2.6 billion in 2019-20, building to a surplus of $10.2 billion in 2020-21.

Net debt is expected to keep climbing, peaking at 19.2 per cent of gross domestic product in the coming financial year, before it is expected to fall to 17.2 per cent by 2020-21.

Of course, governments have been undershooting budget forecasts for almost a decade, and net debt has been rising.

Australia's fiscal strategy came under scrutiny recently from the International Monetary Fund, which released a paper last month looking at the success of our fiscal strategy.

While noting its concern about an upward "drift" in debt levels, the paper observed that Australia's net debt position remains well below the average of other developed nations of 76 per cent.

The paper, titled "Australia's Fiscal Framework: Revisiting Options for a Fiscal Anchor" considered whether it would be better to replace our fiscal strategy with a more explicit commitment to cap rises in net debt.

The authors canvas the rather exciting proposal that the government should allow the rate of the goods and services tax (GST) to fluctuate, as needed, to bring debt under control.

Overall, however, the authors concluded that Australia was doing well to manage its fiscal strategy, and that an explicit debt "anchor" would provide little extra discipline, and may even be counterproductive, forcing taxes to rise at precisely the time when the economy was cooling.

It goes on to conclude that: "The rationale for adopting legislated numerical fiscal rules can be weaker in a country like Australia. It has a well-established record of responsible fiscal policies under governments of different political ideologies."

So, as the political argy bargy over tax cuts and the budget heats up again for 2018, it's a timely reminder that Australia's policy framework has so far served us pretty well.

Provided that any package of tax cuts is small, it can probably sit within the government's professed fiscal strategy.

And perhaps a little fiscal boost, coming at the time when the Resreve Bank of Australia is looking to take the punch bowl away, may not be such a bad thing.

Many economists have called for fiscal policy, particularly infrastructure spending, to play a greater role to relieve some of the burden on monetary policy.

But history argues strongly against trying to use fiscal policy as a tool for management of demand in the economy - outside large external shocks like the global financial crisis.

In ordinary times, monetary policy remains the major instrument for achieving internal balance in the economy, that is, the desired combination of low inflation, low unemployment and a stable rate of economic growth.

The hard truth remains that the budget must be restored to balance, over time, and that must come through a combination of either lower spending or higher taxes.

But the task of reducing government debt is a bit like weight loss.

It's important to set clear goals, and make behavioural shifts in the direction you want to go - cutting spending and increasing revenues.

But it's the long-term trends that matter most, rather than obsessing about arbitrary deadlines.

A little blow out along the way is neither here nor there. The trend is your friend. And fiscal policy is, by and large, heading in the right direction.